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IAS Prelims Exam 2016: GS Economy Questions: Inflation and Business Cycle Set II

Jul 4, 2016 15:59 IST

    From UPSC IAS Examination point of view, the Questions based on Indian Economy are very important. The UPSC IAS Exam aspirants must be aware of the every perspective of Indian Economy either it is historical perspective or current perspective.


    For the Civil Services aspirants, here, we have developed Multiple Choice Questions for the UPSC IAS Prelims Exam based on Ramesh Singh’s Indian Economy book, one of the most important books available for UPSC IAS Exam.


    1.    Which of the following types of inflation is ‘large and accelerating’?
    a.    Creeping inflation
    b.    Galloping inflation
    c.    Hyperinflation
    d.    None of the above

    Answer: c

    Explanation:


    Hyperinflation is ‘large and accelerating’ which might have the annual rates in million or even trillion. In such inflation not only range of increase is very large but the increase takes place in a very short span of time, prices shoot up overnight.

    Creeping inflation is slow and on predictable11 lines which might be called small or gradual. This is a comparative term which puts it opposite to the faster, bigger and unpredictable inflations. Low inflation takes place in a longer period and the range of increase is usually in ‘single digit’.

    We may take an example of the monthly inflation rate of a country for six months being 2.3%, 2.6%, 2.7%, 2.9%, 3.1% and 3.4%. Here the range of change is of 1.1% and over a period of six months.

    2.    Which of the following types of inflation is also known as the hopping inflation?
    a.    Galloping inflation
    b.    Creeping inflation
    c.    Hyperinflation
    d.    None of the above

    Answer: a

    Explanation:


    This is a “very high inflation” running in the range of double-digit or triple digit (i.e. 20%, 100% or 200% a year). In the decades of 1970s and 1980s, many Latin American countries such as Argentina, Chile, and Brazil had such rates of inflation—in the range of 50 to 700 per cent.

    The Russian economy did show such inflation after the disintegration of the ex-USSR in the late 1980s. Contemporary Journalism has given some other names to this inflation—hopping inflation, jumping inflation and running or runaway inflation.

    3.    With reference to the ‘bottleneck inflation’ which of the following statements is correct?
    a.    Bottleneck inflation takes place when the supply falls drastically and the demand remains at the same level.
    b.    Bottleneck inflation takes place when the supply falls drastically along with the demand.
    c.    Bottleneck inflation takes place when the supply increases rapidly and the demand remains at the same level.
    d.    Bottleneck inflation takes place when the supply increases rapidly along with the demand.

    Answer: a

    Explanation:


    This inflation takes place when the supply falls drastically and the demand remains at the same level. Such situations arise due to supply-side accidents, hazards or mismanagement which is also known as ‘structural inflation’. This could be put in the ‘demand-pull inflation’ category.

    4.    Consider the following statements regarding the ‘Inflationary gap’:
    I.    The shortfall in total spending of the government (i.e. fiscal surplus) over the national income creates inflationary gap in the economy.
    II.    The excess of total government spending above the national income (i.e. fiscal deficit) is known as the inflationary gap.

    Which of the following statement(s) is/are correct?
    a.    Only I
    b.    Only II
    c.    Both I and II
    d.    Neither I nor II

    Answer: c

    Explanation:

    The excess of total government spending above the national income (i.e. fiscal deficit) is known as the inflationary gap. This is intended to increase the production level which ultimately pushes the prices up due to extra-creation of money during the process.

    5.    The excess of total government spending above the national income (i.e. fiscal deficit) is known as:
    a.    Inflationary gap
    b.    Deflationary gap
    c.    Fiscal Deficit
    d.    None of the above

    Answer: b

    Explanation:


    The shortfall in total spending of the government (i.e. fiscal surplus) over the national income creates deflationary gap in the economy.

    This is a situation of producing more than the demand and the economy usually heads for a general slowdown in the level of demand. This is also known as the output gap.

    6.    Consider the following statements regarding the inflation tax:
    I.    The level of deficit financing is directly reflected by the rate of inflation.
    II.    Inflation is always the level to which the government may go for deficit financing.
    III.    The governments in the form of prices and incomes policy under which the companies pay inflation tax on the salary increases above the set level prescribed by the government.

    Which of the following statement(s) is/are correct?
    a.    Only I
    b.    I and II
    c.    II and III
    d.    All of the above

    Answer: d

    Explanation:


    Inflation erodes the value of money and the people who hold currency suffer in this process. As the governments have authority of printing currency and circulating it into the economy (as they do in the case of deficit financing), this act functions as an income to the governments.

    This is a situation of sustaining government expenditure at the cost of people’s income. This looks as if inflation is working as a tax. That is how the term inflation tax is also known as seignorage. It means inflation is always the level to which the government may go for deficit financing—level of deficit financing is directly reflected by the rate of inflation.

    It could also be used by the governments in the form of prices and incomes policy under which the companies pay inflation tax on the salary increases above the set level prescribed by the government.

    7.    An inflationary situation in an economy which results out of a process of wage and price interaction ‘when wages press prices up and prices pull wages up’ called:
    a.    Inflationary gap
    b.    Deflationary gap
    c.    Inflation spiral
    d.    Seignorage

    Answer: c

    Explanation:

    An inflationary situation in an economy which results out of a process of wage and price interaction ‘when wages press prices up and prices pull wages up’ is known as the inflationary spiral. It is also known as the wage-price spiral.

    This wage-price interaction was seen as a plausible cause of inflation in the year 1935 in the US economy, for the first time.

    8.    When a firm calculates its profits after adjusting the effects of current level of inflation, this process is known as:
    a.    National income accounting
    b.    Inflation Accounting
    c.    Super Normal Profit
    d.    Normal Profit

    Answer: b

    Explanation:

    The term Inflation Accounting is popular in the area of corporate profit accounting. Basically, due to inflation the profit of firms/companies gets overstated.

    When a firm calculates its profits after adjusting the effects of current level of inflation, this process is known as inflation accounting. Such profits are the real profit of the firm which could be compared to a historic rate of inflation (inflation of the base year), too.

    9.    Phillips Curve advocates a relationship between which of the two aggregates of an economy?
    a.    Inflation and unemployment
    b.    Demand and Supply of money
    c.    Supply of money and rate of interest
    d.    Rate of interest and unemployment

    Answer: a

    Explanation:

    It is a graphic curve which advocates a relationship between inflation and unemployment in an economy. As per the curve there is a ‘trade off’ between inflation and unemployment i.e. an inverse relationship between them.

    The curve suggests that lower the inflation, higher the unemployment and higher the inflation, lower the unemployment.

    During 1960s, this idea was among the most important theories of the modern economists. This concept is known after the economists who developed it— Alban William Housego Phillips (1914–75). Bill Phillips (popular name) was an electrical engineer from New Zealand and was an economist at the London School of Economics when propounded the idea.

    10.    Consider the following statements regarding NAIRU:
    I.    When the monetary policy tried to hold unemployment below its natural rate, inflation will be rising to higher level called -accelerating inflation rate of unemployment (NAIRU).
    II.    The NAIRU is that rate of unemployment which is consistent with a constant rate of inflation.
    III.    The NAIRU is the lowest unemployment rate that an economy can sustain without any upward pressure on inflation rate.

    Which of the following statement(s) is/are correct?
    a.    Only I
    b.    I and II
    c.    II and III
    d.    All of the above

    Answer: d

    Explanation:


    According to the American economists, Milton Friedman and Edmund Phelps if monetary policy tried to hold unemployment below its natural rate, inflation will be rising to higher level—which is known as the non-accelerating inflation rate of unemployment (NAIRU) also. The NAIRU is that rate of unemployment which is consistent with a constant rate of inflation. It means at NAIRU, the upward and downward forces on price (inflation) and wage (unemployment) neutralise each other and there is no tendency of change in the rate of inflation. We may say that the NAIRU is the lowest unemployment rate that an economy can sustain without any upward pressure on inflation rate.

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